Jobless rate may not have peaked

Does the unexpected fall in unemployment in March mean the worst of the labour market numbers are behind us?

I doubt it.

To start with, the official data still show the unemployment rate rising at a trend rate of about 0.1 of a percentage point a quarter. But the more widely used seasonally adjusted data also raise doubts about whether the unemployment rate has peaked.

The seasonally adjusted unemployment rate fell from 6.1 per cent in February to 5.8 per cent in March when economists had been expecting a further small increase in the rate.

At the same time, employment, which was expected to take a breather after February’s strong 48,000 increase, grew by another 18,000 jobs. Employment has risen 88,000 so far this year, in a lagged but stronger than expected response to the acceleration in economic growth from the middle of last year.

The stronger employment numbers and the possibility that unemployment might have peaked naturally triggered speculation that the Reserve Bank would bring forward the start of the next monetary policy tightening cycle, with the first rise in the cash rate in the second half of this year.

There is of course a reasonably close relationship between changes in the unemployment rate and the monetary-policy interest rate, because the unemployment rate has an important influence on the inflation rate that the RBA targets. This relationship is depicted in the top graph, in which annual changes in the unemployment rate are inverted and set against annual changes in the RBA’s official cash rate.

HSBC’s Paul Bloxham could have been speaking for other financial sector economists when he offered clients this assessment of the March labour force data:

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“The labour market is improving, with the unemployment rate falling to 5.8 per cent, and now likely to be passed its peak.

“Combined with a lift in activity, and inflation that is already in the upper half of the RBA's target band, we see the RBA as likely to start considering that rates may need to head back towards neutral fairly soon. We continue to expect the RBA to lift its cash rate before the end of the year."

Not everyone so upbeat

However, there are doubters who point to both the fall in full-time employment and a significant fall in the labour force participation rate in the March data.

Westpac’s Justin Smirk warned his bank’s clients that the stronger than expected employment numbers did not explain why the unemployment rate fell from 6.1 per cent to 5.8 per cent.

“This is explained by the surprising large fall in participation rate, from 64.9 per cent to 64.7 per cent," he said.

“If the participation rate had held at 64.9 per cent, the unemployment rate would have been 6.0 per cent in March. That is, the fall in the participation rate was worth 0.2 percentage points of the 0.3 percentage point fall in the unemployment rate."

Westpac is forecasting the unemployment rate to peak at 6.5 per cent late in 2014.

“With a stable participation rate, we estimate the Australian economy has to add 20,000 jobs per month just to hold the unemployment rate steady," Smirk says.

“However, if there is a resumption of the trend decline in participation then the requirement is much less than that. If this is the case, then it is possible we may have seen the peak in the unemployment rate."

But is there any sign in the data of that resumption of the trend decline in participation rates?

Take a look at the second graph. It’s early days, but to me it looks like the participation rates for both men and women may be starting to head up rather than down.

The male participation rate looks like it might have bottomed in January and is now at the start of a rising trend. The rebound in the female participation rate since December is stronger and perhaps reflects the employment growth in education and healthcare since the September quarter of last year.

Uncertainty over participation rates

We can’t be sure about where participation rates will go, of course. If you look back to 2010, the male participation rate appeared to be recovering through the second half of that year, only to slip into its long-trend decline in December of 2010.

But a turnaround in the participation rates of men and women would be consistent with the current increase in labour demand.

Searching for work consumes time and money. People leave the labour market when they perceive that there are no jobs to find, and then re-enter it when the probability of finding work increases.

There also may be supply-side factors at work. Wages growth has slowed, while the recovery of the housing market means that many households are taking on new debt. The combination of weak wages growth and increased debt is likely to have induced more married women to seek paid work.

The argument about monetary policy is interesting. Obviously there is a qualitative difference between a fall in unemployment that is driven by an increase in employment and one that is the result of people retreating from the labour market.

The RBA’s inflation target is consistent with the economy growing at a healthy clip.

But it is possible to imagine how a further retreat of “discouraged workers" from the labour market could bring forward the day when the RBA feels compelled to increase rates.

While economists say the decline in the participation rate is due partly to population ageing, most of the decline is simply the result of the cyclical weakness in employment. The current weak wages growth is symptomatic of that weak labour demand.

When non-mining business investment finally starts coming back to life, the RBA will be under pressure to lift the official cash rate from its present very low level of 2.5 per cent.

That pressure will be all the greater if the cyclical decline in participation rates has become more structural in nature because discouraged workers have sunk into involuntary retirement.